Financial Development, Institutions And Economic Policy - Panel Data Evidence

In recent years significant researches have been done to identify what are the determinants of financial development. With regard to this outline, the main objective is to investigate the effect of economic, political and social dimension of institutional quality, as well as the effect of political and macroeconomic factors on financial development. More specifically, the present work aims to contribute to the relevant literature in the following ways: i) in the econometric front, we employ dynamic panel techniques, that allow for heterogeneity among variables, avoiding the known problems of traditional techniques. More specifically, we employ the "system GMM" estimator developed by Arellano and Bover (1995), and Blundell and Bond (1998), controlling for endogeneity among variables; ii) we disentangle into economic, political and social institutional quality in order to quantify the effect of institutions on financial development and check the robustness of our results; iii) in the same logic, we decompose our measure of financial openness into equity- and loan-related foreign assets and liabilities in order to assess whether the hoarding of risky vs. riskless assets or the accumulation of equity vs. debt liabilities affect the development of domestic financial institutions; and iv) to control for a potential bias among variables, we include a large set of information, which covers all the spectrum of possible effects on finance, giving emphasis on political factors and government policies. Our main finding from the regression analyses is a robust empirical relationship from institutions to financial development, a result consistent with most empirical studies. Also, we find a stronger effect from economic institutions to banking sector development and from political institutions to stock market development. Regarding the trade and finance link, we find that openness has a much stronger association with bank-based finance than with stock market development, a similar finding with that of Huang and Temple (2005). As for financial openness, equity-related assets and liabilities have a more robust impact on financial development. Finally, government policy in terms of less government enterprises / government investment and interest rate liberalization have a significant effect on the banking sector rather on the stock market sector.